Pension changes debate: How much, how soon?

Gov. Dannel P. Malloy presents his first two-year budget on Feb. 16, 2011, during a joint session of the General Assembly at the Capitol, in Hartford. The plan raised taxes across-the-board, sought $2 billion in savings from state employees and attempts to cut spending without stripping programs for the needy.Jessica Hill/AP Photo

While Democrats under the leadership of Gov. Dannel P. Malloy may have begun to repair the state's broken pension system, their Republican critics say the party in power remains unwilling in this election year to take the tough actions necessary to truly fix the problem.

Democrats are proud of what they accomplished in 2011 and 2012 and believe the state will keep its promises to state employees and retirees. Republicans say the state's budget can't withstand the increasing pension costs and it is time to seriously consider 401(k)-type retirement plans as the private sector has done.

"I am absolutely concerned that retirees might not get their benefits," said state Rep. Vincent Candelora, R-North Branford, who serves on the legislature's Finance, Revenue and Bonding Committee. "We continue to run down cash, replaced taxing with borrowing in the last biennium. Connecticut is in a spiral, despite what the administration says."

Malloy said he has obtained more savings on pension and retiree health benefits than former governors and legislatures. He said he doesn't plan to reopen the State Employees Bargaining Agent Coalition agreement in the next four years. State Sen. John McKinney, R-Fairfield, who is running for governor, said whoever wins in November will have to look at reopening the agreement.

"We can't afford the way things are in Connecticut right now," McKinney said, adding that the state can't continue to go down the road where it makes promises that it can't keep.

"I think we need to look at, in particular, new employees who are hired, and more of a defined contribution plan instead of a defined benefit plan," McKinney said.

Malloy and Speaker of the House of Representatives Brendan Sharkey, D-Hamden, said they would consider a 401(k)-type plan when they sit down with the unions at the negotiation table. But Sharkey and Malloy's budget chief, Benjamin Barnes, said they see no budget crisis that warrants reopening the SEBAC agreement, which is in effect until 2022.

If the state had to pay for pensions on a cash basis, that would be a crisis, Sharkey said.

"We are not there," he said. "And particularly, when we see the trajectory of committing to fully funding the pension, I think we are certainly pushing off that doomsday scenario well off into the future."

Newest projections

The latest news is good and bad. The state's liability for retirees' health claims has decreased. Malloy terminated agreements that allowed the state to contribute less than actuaries recommend, leading to larger state contributions to pension funds. But because the state is projecting lower investment returns and more state employees retired in 2011 than anticipated, the main pension's liability has increased.

The most recent actuarial projection shows the state appropriating up to $2.5 billion in 2032 to close the unfunded liability of the major state pension, the Connecticut State Employees' Retirement System. That would have been more than $4 billion if there had not been an agreement to contribute what actuaries recommended and if the 2011 SEBAC agreement had not included wage freezes and a new retirement tier with reduced benefits.

"Our plan includes properly funding the pension plans so that we get to 85 percent and 100 percent funding without ever having to cross a threshold that would be unsustainable," Malloy said.

Both political parties shared in the decisions to underfund the pension system. Former Republican Gov. John G. Rowland negotiated SEBAC agreements in 1995 and 1997, which allowed the state to contribute less to the pension system than actuariesrecommended. Former Republican Gov. M. Jodi Rell continued with a reduced contribution. Democrats, in control of the state House and Senate since 1997, approved state budgets that included postponing pension contributions.

There would be about $2 billion more in the state employees' pension fund had the state not reduced its contributions, according to the Office of the State Comptroller.

"Some of the things that my predecessor governors did actually lock me and the people who will follow me as governor into situations that you can't simply just wave your hand and change," Malloy said, "and that's why hard, tough bargaining that led to agreements that save billions of dollars is an achievement. There's nobody in the legislature with that kind of track record. There is no prior governor with that kind of track record in our state."

On Thursday, Malloy administration officials said savings from terminating Rowland's agreements with SEBAC will be about $720 million. In 2012, Malloy's office had predicted $5.8 billion in savings. The year before, the administration had predicted about $21.5 billion would be saved because of the SEBAC 2011 agreement, but six months later, the nonpartisan Office of Fiscal Analysis disagreed with those numbers.

One reason for the decreasing projected savings is that the state reduced its assumed investment rate of return from 8.25 percent to 8 percent, increasing the calculated liability of the pension fund by $1.2 billion, according to the Office of Policy and Management.

Under SEBAC 2011, all state employees are, as of July 1, 2013, contributing to their retiree health benefits for the first time. The state will start matching employee contributions to the retiree health fund in 2017. The state's contribution is projected to be $129.5 million that year, according to OPM.

A 2013 report by The Segal Group Inc., an actuarial firm, found that the state's liability for retiree health benefits is now expected to be $16.2 billion, $15 billion less than expected.

Impact of overtime

McKinney said he thinks a lot of things still need to be changed in the agreement with SEBAC, which negotiates on behalf of 15 unions that represent about 45,000 state employees.

"Malloy did get a change in retirement age - three years. Rell was able to make certain changes andthat is an evolving part of our society, where people are living longer, working longer," he said.

The state needs to examine whether overtime should be calculated into base pay for pension purposes and whether employees contribute enough, he said.

The Day's analysis of the state pension system found nearly 26 percent of the 82 state troopers and sergeants who retired in 2011 had a spike in overtime during the last three years of service, which increased their annual pensions.

"Allowing people to have that overtime calculated into base pay for pensions has led to a lot of pension spiking as people increase their pension before retirement," McKinney said. "I think we need to take a very hard look at what current employees contribute toward their pension. They contribute 2 percent. That is the lowest pension contribution in the nation."

Malloy said he addressed pension contributions by requiring employees to work longer before they are eligible to retire. Employees hired on or after July 1, 2013, are required to work until they are 63 if they have 25 years of service or 65 if they have 10 years of service for normal retirement. Current employees who retire after July 1, 2022, must also be three years older than previously required.

'Pension payment holidays'

Connecticut has a track record of not funding its pensions: The State Employees' Retirement System is funded at 42 percent and the State Teachers' Retirement System at 55 percent.

When asked whether the state would continue to make the annual required contributions, Malloy said in an interview last month that now that the state is using Generally Accepted Accounting Principles, it would be difficult for a future governor not to budget the annual required contribution.

"Having adopted GAAP, if we were to decide to not enforce (pension contributions) the penalty at the bond market would be so egregious that governors can't do it," Malloy said. Generally Accepted Accounting Principles is a term for an accounting method that matches income earned and expenses incurred in the same period.

But Julie E. McNeal, director of finance and operations for the Connecticut Society of CPAs, said whether the bond markets would react negatively to the state not funding its pensions could depend on a variety of factors, including the state's economic growth.

The state's bonded debt was $20 billion as of 2013, according to OPM. This, plus the unfunded liabilities for the two major pension plans, the retiree health benefit plans for state employees and teachers, and the remaining debt related to the GAAP conversion, brings the state's total long-term liabilities to $64.6 billion.

To have enough money to make the annual required contributions going forward, Malloy said, the state needs to continue to control spending.

McKinney said the key is to spend less, rather than increase taxes.

"If you talk to financial analysts, people in the business community, they are well aware of our pending unfunded or underfunded obligation, and our ability to meet those may very well mean significantly higher taxes, which puts a dark cloud on business growth and business investment in the state of Connecticut," he said.

The administration proposed and the General Assembly passedthe largest tax increase in recent history - $1.5 billion annually - in 2011. Barnes said much of that increase could have been avoided if the state hadn't taken "pension payment holidays."

Candelora, the North Branford Republican who serves on the legislature's Finance, Revenue and Bonding Committee, said he has been pushing for a bill to commit a certain portion of the state's capital gains tax revenue to funding the pension, but the bill has never passed.

Sharkey said many states run into problems when they earmark revenue, such as lottery winnings, for a specific use.

"It takes real solutions," he said. "It is getting leaders who are committed and understand the seriousness of these issues so they can offer some consistency in the out years to maintain the commitment."